Elements of Financial Statements

These lectures cover CPA questions that cover basic elements of financial statements such as assets, liabilities, equity comprehensive income, revenue and expense.

Elements of Financial Statements

Basic Elements

An important aspect of developing any theoretical structure is the body of basic elements or definitions to be included in it. Accounting uses many terms with distinctive and specific meanings. These terms constitute the language of business or the jargon of accounting.

One such term is asset. Is it merely something we own? Or is an asset something we have the right to use, as in the case of leased equipment? Or is it anything of value used by a company to generate revenues—in which case, should we also consider the managers of a company as an asset?

As this example and the lottery ticket example in the opening story illustrate, it therefore seems necessary to develop basic definitions for the elements of financial statements. SFAC No. 6 defines the 10 interrelated elements that most directly relate to measuring the performance and financial status of a business enterprise. We list them below and for review and information purposes; you need not memorize these definitions at this point. We will explain and examine each of these elements in more detail in subsequent chapters.

The FASB classifies the elements into two distinct groups. The first group of three elements—assets, liabilities, and equity—describes amounts of resources and claims to resources at a moment in time. The other seven elements describe transactions, events, and circumstances that affect a company during a period of time. The first class, affected by elements of the second class, provides at any time the cumulative result of all changes. This interaction is referred to as “articulation.” That is, key figures in one financial statement correspond to balances in another.

ASSETS.

Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

LIABILITIES.

Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

EQUITY.

Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest.

INVESTMENTS BY OWNERS.

Increases in net assets of a particular enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests (or equity) in it. Assets are most commonly received as investments by owners, but that which is received may also include services or satisfaction or conversion of liabilities of the enterprise.

DISTRIBUTIONS TO OWNERS.

Decreases in net assets of a particular enterprise resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Distributions to owners decrease ownership interests (or equity) in an enterprise.

COMPREHENSIVE INCOME.

Change in equity (net assets) of an entity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

REVENUES.

Inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.

EXPENSES.

Outflows or other using up of assets or incurrences of liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations.

GAINS.

Increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investments by owners.

LOSSES.

Decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distributions to owners.